December 1st, 2009

A Survey of Capital Allocation Metrics: Illustration

Posted at 1:00 AM ET

Susan Witcraft, Managing Director, Financial Intelligence Team, Instrat
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To understand the differences in proportional capital allocation methods, it helps to have a reference point. Consider a simple hypothetical insurer that writes auto, general liability, workers’ compensation and property business. The loss distributions are a bit exaggerated to highlight some of the differences among metrics. A profile of the company’s business is shown in Figure 1.

capitalallocation1

The company has a 30 percent expense ratio. Current accident year losses and changes in reserve estimates are assumed to be positively correlated within and across lines, with correlations ranging from 0 percent to 50 percent. The expected profit is approximately USD55 million on surplus of USD350 million, for an expected pre-tax return on surplus of just under 16 percent. Investment and credit risk are ignored in this illustration.

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Part I: Introduction >>

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Guy Carpenter & Company, LLC provides this material for general information only. Guy Carpenter & Company, LLC makes no representations or warranties, express or implied. The information is not intended to be taken as advice with respect to any individual situation and cannot be relied upon as such.

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